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Like The Green Lobby, Big Oil Companies Fear Shale Revolution

Big oil companies admit they are ‘losing their shirts’ due to the shale gas boom and low gas prices. It all stands in stark contrast to a couple of years back when oil majors were telling shareholders not to worry, ‘we’re Big Gas as well’.

Quarterly results are normally a fairly predictable affair in energy. Depending on what companies have been up to – some are up, some are down – but they all ultimately reflect whatever’s been happening on international oil markets. With benchmark prices averaging historic highs ($114/b) in the first half of the year, bumper profits should be rolling in. And true enough, big oil has delivered some big results this time round. But read between the ‘numbers’, and it’s becoming alarmingly clear – big oil has major problems cross subsidising cheap gas right now, and nowhere more so than in the United States. Something has to give.

Take Exxon Mobil as the best example. Breakdown its second quarter $15.9bn profits, (up $5.2bn from last year), and they start to look less impressive. It made handsome returns spinning off a Japanese refining unit, further buttressed by $7.5bn divestments and tax related items, which once subtracted, leaves you with a rather more modest $8.4bn. That’s not the worrying bit for the Houston major, but the fact that Exxon only made $678m in its US upstream operations due to depressed gas prices. The consistent line from Rex Tillerson was that Exxon had deep enough pockets to invest through the cycle after its acquisition of XTO in 2010. Not so last month; Tillerson admitted energy companies were ‘losing their shirts’ from low gas prices.

European majors are no different. Royal Dutch Shell posted seemingly decent $5.7bn earnings, but they actually chalked up a ‘$1bn’ fall on last year’s figures. The core reason was depressed US gas prices – that have become low margin at best – negative plays over full cycle economics at worst. Just ask UK based BG Group, they just wrote off $1.3bn in US natural gas assets and associated impairment charges, seeing pre-tax profits slip to $609m. That’s before you go through the long list of US shale players that have been slapped with impairments over the past year. Anadarko Petroleum, Noble, Encana, SM Energy, and of course the ‘poster boy’ of shale gas frack-ups, Chesapeake, that’s racing against the write down clock, trying to court finance from wherever (and whoever) they can. As a corollary, many analysts expect BHP Billiton to face thwacking write downs from $19bn shale purchases from Chesapeake and Petrohawk in 2011.

No doubt bullish (sp?) estimates on shale acreage haven’t helped; it’s always a fine line between ‘optimistic’ price forecasts and overbooking reserves, but the real problem here is American shale becoming an increasingly lame prospect to sink future capital. That certainly applies to US mid-caps that have to keep sourcing external financing to develop new plays, on the spurious basis they can claim some kind of ‘net present value’. Even for bigger international beasts that can leverage their own balance sheets at minimal cost, shareholders would expect them to find far better value beyond US shores.

It all stands in stark contrast to a couple of years back when oil majors were telling shareholders not to worry, ‘we’re Big Gas as well’. Shell boasted that 55% of its overall output would come from gas by 2012, with seven out of the eight projects completed by Exxon all coming from natural gas developments in 2010. Not exactly news many equity analysts would be cheerful about today, particularly with serious cost overruns afflicting fiddly LNG developments globally.

But as far as the US is concerned we can expect several things to happen. The first is IOCs will increasingly get into wets to offset dry shale economics. That can already be seen from Shell, and indeed, explains many of Chesapeake’s woes getting caught short balancing their portfolio away from low margin shale. The second is an ongoing shift from coal to gas (a move that’s clipped US emissions by 450 million tones over the past five years). Many will also talk up the gasification of US transport to help firm prices (and ‘screw’ OPEC in the process). All ‘nice stuff’, but it holds zero interest for big oil. If they’re going to keep faith with US shale and invest through the cycle, that means taking a serious look at gas-to-liquids and far more importantly, LNG export potential to capitalise on enormous spreads between the US and Asia. Shell has said as much; BG Group is banking on exactly that coming good, otherwise it’s just made the worst corporate bet in history. Get FERC to fast track LNG export facilities, and prices should firm on Henry Hub – at least to get the majority of US shale plays back in the black.

The US can of course just keep ignoring this – hope that prices organically firm, or that further technology gains drive wider margins ‘feasible’ for IOCs to keep cross subsidising US gas production. Maybe so, but it’s worth remembering that big oil operates on a global basis, which inevitably entails opportunity-costs wherever they decide to set up shop. Continually haemorrhaging cash on US shale isn’t really part of the script, not unless they stick around and wait for Chesapeake et al. to implode and pick up the pieces. But even then, it’s the long term export potential IOCs really want, both for oil and gas.

Economics makes that a very simple proposition, just as politics makes it fiendishly difficult. But before the folks in Washington decide which way to go on exports, they should consider a final twist in the shale gas tale: The more gas America keeps at home, the more likely it becomes that the only international investment they’ll attract is from Asian National Oil Companies. After all, if the economics don’t stack up, that only leaves those with a strategic mandate at the table. No doubt that’s what most IOCs are banking on if they finally decide to call time on US shale. Bailing out to Beijing?

Forbes, 27 July 2012